No Cost of Living Adjustment for Social Security… Again

Executive Summary

On Friday, the Social Security Administration announced that there would be no increase in Social Security benefits for 2011, representing the 2nd consecutive year that Social Security benefits have not increased… and prompting no small amount of outrage from many Americans who feel that they are falling further and further behind in their ability to keep up with their retirement expenses.

The announcement from the Social Security Administration comes at the conclusion of their annual process of calculating the cost-of-living adjustment (COLA) for the coming year, which evaluates the level of the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) over the three month period of July, August, and September, and compares it to the levels the last time a COLA was applied. In this case, the latest COLA calculation reveals that the price level of the CPI-W is still below where it was in 2008, and accordingly, there is no change in Social Security payments for the coming 2011 year.

In point of fact, the lack of any COLA adjustment affects not just the level of Social Security retirement benefits; it also means that there will be no change to Supplemental Security Income (SSI) benefits, the Social Security wage base, the amount of earnings required to earn one quarter of coverage for Social Security credit, the retirement earnings amount necessary to trigger a reduction in benefits, and more. (For a full list of COLA adjustments {or lack thereof}, see the 2011 summary of Social Security changes.)

Of course, the theoretical purpose of a cost-of-living adjustment is to help recipients’ spending keep up with the general level of inflation – i.e., to maintain a "real" inflation-adjusted standard of living. But as financial planner Rick Kahler notes in his blog, many Americans confuse "nominal" and "real" changes to their benefits; the perception is that the government is failing to give seniors a raise, when in theory the purpose of COLAs is actually to give them only what is needed to keep up with inflation, not to increase their real income. Accordingly, with no net increase in the level of prices in the CPI-W since 2008, there is no need for payment increases.

On the other hand, many claim that the CPI-W is a poor representation of inflation, especially for retirees. Aren’t costs going up in prescription drugs and medical expenses? How can there be no inflation? In point of fact, it’s worth noting that even according to the CPI-W, there has been inflation over the past year, as you can see by looking at the 2009 versus 2010 CPI-W price levels for July through September. However, the chart also reveals that while CPI-W prices have risen from 2009 to 2010, the levels actually dropped from 2008 to 2009 – due in large part to a dramatic decline in energy prices (remember $4/gallon for gasoline at the pump?) and several other inflation factors. Fortunately (at least from the perspective of retirees), Social Security benefits cannot and did not adjust downwards for the CPI-W decline from 2008 to 2009; benefits merely remain flat. And in fact, some make the case that benefits were excessively elevated in 2009, due to the high level of the CPI-W in 2008 (again, heavily attributable to the energy run-up in the summer of 2008), which led at the time to a 5.8% increase in benefits over the prior year. Nonetheless, given that Social Security benefits adjust upwards in positive inflation years but do not decline in negative inflation years, the rules are written to say that benefits also cannot increase until they reach a new high in excess of the prior high; accordingly, even though the CPI-W levels are up over the past year, there is no benefits increase until they exceed the old "high water mark" set by the CPI-W in 2008.

For the clients of many financial planners, Social Security benefit adjustments are a factor in the plan, but not necessarily a crucial one; accordingly, it doesn’t appear that the planning community is up in arms about the lack of a Social Security benefit adjustment. However, as a recent article from the Associated Press points out, the average Social Security retirement benefit is $1,072/month, and Social Security benefits are the primary source of income for 64 percent of retirees who got benefits; other articles have noted that the SSA estimates as many as 1/3rd of recipients rely on Social Security benefits for at least 90 percent of their income. In response, Congress has even been discussing possible legislation to make a $250 payment to seniors receiving Social Security benefits to help them cope with the lack of a Social Security COLA, similar to the payment that is occurring this year to all Medicare Part D recipients, nominally to help them manage the so-called Medicare Part D ‘donut hole’; thus far, though, the $250 payment proposal has made little progress and is being heavily debated.

Fortunately – for those who are frustrated by the lack of Social Security payment increases – the Social Security Trustee Annual Report anticipates under current projections that there will be a COLA increase for 2011 of 1.2%. Ultimately, though, it will depend on the direction of the economy and whether inflation does indeed manifest as projected.

On the other hand, if inflation doesn’t rise or actually declines, one might argue that’s actually better; declining prices without a decline in income (since Social Security cost-of-living adjustments cannot be negative) can actually represent an increase in one’s inflation-adjusted standard of living, albeit not in the manner we usually hope for!

Are your clients feeling a pinch after two years without a cost-of-living adjustment for Social Security benefits? Or are they well represented by the CPI-W, where some costs go up and others go down, but the net result is flat spending to match their flat income?